Stock ETFs: What is a Micro Cap Stock?

If you want to invest your money in companies that are smaller than small, you can invest in ETFs based on micro caps. These companies are larger than the corner delicatessen, but sometimes not by much. In general, micro caps are publicly held companies with less than $300 million in outstanding stock.

Micro caps, as you can imagine, are volatile little suckers, but as a group they offer impressive long-term performance. In terms of diversification, micro caps — in conservative quantity — could be a nice addition to your portfolio, though not a necessity. Take note that micro cap funds, even index ETFs, tend to charge considerably more in management fees than you’ll pay for most funds.

Micros move at a modestly different pace from other equity asset classes. The theory is that because micro caps are heavy borrowers, their performance is more tied to interest rates than the performance of larger cap stocks. (Lower interest rates would be good for these stocks; higher interest rates would not.)

Micro caps also tend to be more tied to the vicissitudes of the U.S. economy and less to the world economy than, say, the fortunes of General Electric or McDonald’s.

Given the high risk of owning any individual micro cap stock, it makes sense to work micro caps into your portfolio in fund form, despite the management fees, rather than trying to pick individual companies.

To date, a handful of micro cap ETFs have been introduced. They differ from one another to a much greater extent than do the larger cap ETFs.